Why Did the G-8 Let Trade Freeloaders Get Away?

The last G-8 meeting, held in Northern Ireland on June 17-18, failed to tackle growth-stifling trade imbalances in the world economy. That was a disappointing outcome of a talk fest which cost taxpayers about $2,000 per delegate per day.

France and Italy, with their sinking economies and soaring unemployment, had every reason to expect that they could ease the pain of their fiscal retrenchment by exporting more, as they hoped that their trade partners with large external surpluses would stimulate their domestic demand.

But these hopes were quickly dashed. A good opportunity was lost to coordinate economic policies in a way that would have supported jobs and output in the stagnating industrialized world.

(Read More: G-8 Says World Economic Prospects Still Weak)

Being a large deficit country, the U.S. could have been expected to act as a strong advocate of more balanced global trade flows. In the first quarter of this year, the American trade deficit – currently running at about 4 percent of the gross domestic product (GDP) - was a drag on economic growth. And that will get worse as the U.S. economy continues to pick up speed, while most other G-8 countries keep fighting recessions or experience tepid aggregate demand.

The best estimates available at the moment indicate that this year and next trade deficits will reduce America's economic growth by up to an entire percentage point.

The U.S. Federal Reserve, of course, is watching all that – and so should the markets – because the monetary policy will be calibrated in accordance with growth, inflation and unemployment.

G-8 Failed to Get Stimulus From Surplus Countries

How could have the G-8 helped to improve the growth outlook of the world economy?

The essential purpose of G-8 is to provide a forum for coordinating economic policies of its member countries. Over time, many other topics have been added to its agenda, but the economy remains the focal point. As the G-8 leaders emphasized in their last week's communiqué, "our urgent priority is to promote growth and jobs."

The coordination of economic policies simply means that (a) countries with low inflation, balanced budgets, trade surpluses and weak growth are expected to stimulate their economies, while (b) countries experiencing rising deficits and inflation have to restrain their domestic demand. These are clear and widely accepted rules of trade adjustment enshrined in the International Monetary Fund's charter (Articles of Agreement). There is no controversy about that.

And these are the rules the G-8 should have followed. Had they done that, this is what would have happened.

The U.S. and Japan should have been commended for supporting the world economy with their strong stimulation of domestic demand, especially since both countries have serious budget and trade deficit constraints. Russia, with a bit of inflation, but with roughly balanced public sector accounts and a trade surplus should have been encouraged to continue its expansionary economic policies. As it turned out, President Putin needed no encouragement because he unveiled a huge program of spending and structural reforms during the St. Petersburg International Economic Forum last Friday.

France and Italy had to get help from exports to their partners' growing economies as they seek to reduce their excessive budget deficits and public debt. Incidentally, and speaking of Russia, Italy is getting some of that help from its participation in Russia's large energy and infrastructure investments.

Germany is a very different case. Its trade surplus is a whopping 7 percent of GDP, the largest of any major economy. By comparison, China, not a G-8 member, has a trade surplus shrinking toward 2 percent of GDP. German public sector accounts are virtually balanced, inflation has decelerated to 1.5 percent and the economy continues to stagnate on the verge of recession.

Washington Agreed to a Free Pass

Clearly, Germany is a textbook case of a country that should vigorously stimulate its economy instead of living off its trading partners.

And what has the U.S.-led G-8 done about reminding Germany of its duty to follow the rules of trade adjustment? Nothing. While the communiqué specifically talks about the current economic situation in U.S., Japan and Russia, there is no mention of Germany. There is only a stern warning to the euro area to keep reducing deficits and implementing structural reforms. Obviously, none of that applies to Germany.

One can easily imagine that France and Italy had very little influence in the G-8 discussions, but it is very surprising that the U.S. would let this huge departure from rules of trade adjustment slip under the carpet. No wonder the communiqué's pledge that "we reaffirm our commitment to cooperate to achieve a lasting reduction in global imbalances, which surplus and deficit countries must address" sounds strange and hollow.

Washington had good economic reasons to insist on stronger domestic demand in Germany in order to reduce that country's excessive – and disruptive - trade surpluses. In the first four months of this year, America's trade deficit with Germany was running at an annual rate of $60 billion, a 10.4 percent increase from the year before. Over the same period, U.S. exports to Germany were falling at a rate of 5 percent.

An additional problem here is that Germany's example is not encouraging other European countries with large trade surpluses – such as Austria, Denmark, Netherlands, Sweden and Switzerland, a total of about 15 percent of the European economy - to stimulate their domestic demand to move Europe out of recession and to expand markets for American exports of goods and services.

All this should give pause for thought to those who are strongly advocating the creation of a trans-Atlantic free trade area. It is doubtful that, in this particular case, the U.S. economic interests would be well served in a customs union with countries which do not follow trade adjustment rules, and whose policies are based on export-driven growth.

As the evidence so far clearly indicates, such a union would further aggravate U.S. trade deficits and would operate as a powerful drag on American output and employment.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia Business School.